Neoclassical School - Alfred Marshall PDF

HISTORY OF ECONOMIC THOUGHT ALFRED MARSHALL THE NEOCLASSICAL SCHOOL CELERIDAD, COLUMNA, CRUZ, PANESA, SWING CONTENT 01 MARSHALL’S LIFE AND METHOD 02 UTILITY AND DEMAND 03 BEHAVIORAL ECONOMICS: ARE...

HISTORY OF ECONOMIC THOUGHT ALFRED MARSHALL THE NEOCLASSICAL SCHOOL CELERIDAD, COLUMNA, CRUZ, PANESA, SWING CONTENT 01 MARSHALL’S LIFE AND METHOD 02 UTILITY AND DEMAND 03 BEHAVIORAL ECONOMICS: ARE WE RATIONAL? 04 SUPPLY 05 EQUILIBRIUM PRICE AND QUANTITY 06 DISTRIBUTION OF INCOME 07 INCREASING AND DECREASING COST INDUSTRIES MARSHALL’S LIFE AND METHOD ALFRED MARSHALL (1842-1924) Alfred Marshall was the most influential economist of his generation. His work helped to create neoclassical economics, which synthesized insights from earlier schools of economic thought like the classical school and the marginalist school. His book, Principles of Economics, was the standard economics textbook for many years. Marshall viewed economics as a tool to understand how people make decisions in their everyday lives in order to acquire and use "the material requisites of wellbeing." MARSHALL’S LIFE AND METHOD Born in 1842, the son of a cashier at the Bank of England, Marshall's early life was shaped by his domineering father who tried to steer him toward a career in the ministry. However, Marshall rejected his father's wishes, choosing instead to study mathematics and economics at Cambridge. He later became a professor at Cambridge, where he had a profound impact on the development of economic thought MARSHALL’S LIFE AND METHOD A brilliant mind, Marshall nonetheless struggled with some personal difficulties. He was known to be a hypochondriac, and he was intensely self-critical of his own writing. This led him to discard much of his work and to delay publication for many years. However, Marshall's meticulous nature and his commitment to rigorous analysis ultimately made his contributions to economics even more profound and lasting. His magnum opus, Principles of Economics, first published in 1890, became the standard economics textbook for decades and continues to be studied by economists today. MARSHALL’S LIFE AND METHOD MARSHALL WAS A GIFTED MATHEMATICIAN, BUT HE WAS WARY OF THE OVERUSE OF MATHEMATICS IN ECONOMIC ANALYSIS. HE BELIEVED THAT WHILE MATH COULD BE A USEFUL TOOL TO SIMPLIFY AND ILLUSTRATE ECONOMIC CONCEPTS, IT SHOULD NOT BE THE PRIMARY WAY TO DEVELOP THOSE CONCEPTS. One of Marshall's most Marshall introduced a number of Marshall believed that important contributions to important economic concepts, economics was a study of economics was the creation including consumer surplus, "mankind in the ordinary of a theoretical framework elasticity of demand, and the business of life."4 He saw that combined the best representative firm. He economics as a tool to ideas of classical economics stressed the importance of time understand how individuals and societies make choices about and the marginalist school. in economic analysis, how to use scarce resources to His work integrated ideas differentiating between short- satisfy their wants and needs. He about supply and demand, run and long-run outcomes. defined economics as the study marginal utility, and Marshall believed that of actions related to the production costs into a economics should focus on how "attainment and… use of the people attain and use "the material requisites of wellbeing." rigorous system of economic analysis. material requisites of wellbeing." MARSHALL’S LIFE AND METHOD In contrast to the classical economists, who believed that economic laws were akin to natural laws, Marshall saw economic laws as rooted in human behavior. He recognized that economic outcomes are influenced by social institutions and individual choices, and he believed that economic analysis could be used to inform and guide social policy. He felt that while economics should be pursued with scientific rigor, it could also be applied to real- world problems to try to improve people's lives. Marshall's influence on the development of economic thought is immeasurable. His ideas continue to shape how economists think about a wide range of issues. His focus on rigorous analysis, his careful attention to the role of time, and his integration of classical and marginalist ideas laid the foundation for modern microeconomics. His work remains a testament to the power of clear thinking and the importance of combining theory with empirical observation. UTILITY AND DEMAND MARGINAL UTILITY The law of diminishing marginal utility: Satisfaction decreases as more units are consumed. Two key qualifications by Marshall: Short-term analysis excludes changes in tastes over time. Indivisible goods may yield disproportionate utility when completing a task (e.g., wallpaper or tires). Utility measured in monetary terms: Money reflects preferences through willingness to pay. UTILITY AND DEMAND RATIONAL CONSUMER CHOICE Consumers allocate spending to maximize utility. Spending adjusts so that the marginal utility per unit of cost is equal across all goods. Practical example: Deciding between new clothes or a vacation involves comparing marginal utilities. UTILITY AND DEMAND THE LAW OF DEMAND Derived from marginal utility and rational choice. When the price of a product drops: Substitution Effect: Consumers buy more of the cheaper product. Income Effect: Purchasing power increases, potentially increasing demand. Illustrated by the downward-sloping demand curve: Price falls → Demand rises; Price rises → Demand falls. UTILITY AND DEMAND ARE WE RATIONAL? Rationality in Traditional Economics Individuals are rational utility maximizers who process information accurately Are We Always Rational? Kahneman & Tversky - ‘Rules of thumb’, which leads to biased and irrational decisions Prospect Theory: People prefer guaranteed gains & uncertain losses, defying traditional rationality assumptions UTILITY AND DEMAND ARE WE RATIONAL? Implications of Irrational Behavior Irrational decisions are common and systematic This challenges the mainstream view that irrational actions are exceptions, not norms So Are We Rational? Prospect Theory: individuals deviate from rationality Milton Friedman: models assuming rationality are valid if they predict behavior accurately We may not always act rationally, but the rational model can still hold value if it explains our actions effectively UTILITY AND DEMAND CONSUMER’S SURPLUS What is Consumer’s Surplus? Difference between the price a consumer pays for a product or service and the price they would be willing to pay CS = willingness to pay - actual payment Implications in Economics Consumer's surplus grows as prices decrease due to efficient production It is a useful measure to analyze the effects of policies, like taxes or tariffs, on consumer welfare and market efficiency. UTILITY AND DEMAND CONSUMER’S SURPLUS Example of CS Supposed you are buying apples, and your willingness to pay for each apple is as follows: 1st apple, ₱25 2nd apple, ₱20 3rd apple, ₱15 4th apple, ₱10 5th apple: ₱5 If the price of an apple is ₱10, how much consumer surplus do you have if you buy 4 apples? UTILITY AND DEMAND CONSUMER’S SURPLUS Solution Add total willingness to pay for 4 apples ₱25 + ₱20 + ₱15 + ₱10 = ₱70 Add actual payment for 4 apples ₱10 x 4 apples = ₱40 Calculate CS CS = willingness to pay - actual payment CS = ₱70 - ₱40 = ₱30 UTILITY AND DEMAND ELASTICITY OF DEMAND Definition Elasticity of demand (Ed) measures how sensitive the quantity demanded of a good is to changes in price. Calculated by dividing the percentage change in quantity demanded by the percentage change in price. Ed Formula: UTILITY AND DEMAND ELASTICITY OF DEMAND Types of Elasticity Elastic Demand: Ed > 1 large change in Qd for a small change in P Inelastic Demand: Ed < 1 small change in Q for a change in P Unit Elastic Demand: Ed = 1 percentage change in Qd = percentage change in P UTILITY AND DEMAND ELASTICITY OF DEMAND Determinants of Elasticity Price relative to income goods with high prices tend to have more elastic demand Availability of substitutes more substitutes, the more elastic the demand Necessity vs. Luxury necessities; inelastic demand luxuries; more elastic UTILITY AND DEMAND ELASTICITY OF DEMAND Applications of Elasticity Taxation govt tax goods with inelastic demand for higher revenue Pricing Strategy monopolies set higher prices where demand is inelastic Agricultural Output farmers can increase revenue if demand for their product is inelastic SUPPLY MARSHALL’S CONCEPT Supply and Cost of Production Supply is governed by the cost of production. Not a single amount but a curve showing various quantities at different prices. Time Periods in Supply Analysis Immediate Present Supply is fixed; there is no time to adjust production. Short Run Some adjustments are possible, but capacity constraints remain. Long Run All production factors can adjust; full flexibility. EQUILIBRIUM PRICE AND QUANTITY Classical Economists Cost of production (objective labor-time cost and abstinence). Early Marginalists Focused on demand. Alfred Marshalls’s Synthesis Both supply and demand determine market price. EQUILIBRIUM PRICE & QUANTITY NUMERICAL REPRESENTATION EQUILIBRIUM PRICE & QUANTITY GRAPHICAL REPRESENTATION DISTRIBUTION OF INCOME WAGES Determined by marginal productivity and demand-supply dynamics. Affected by labor supply changes and derived demand for final products. Employers optimize labor costs where wage rate = marginal revenue product (MRP). DISTRIBUTION OF INCOME INTEREST Reward for postponed consumption and savings. Determined by demand and supply of capital in markets. Lower interest rates increase investment; higher rates encourage saving. DISTRIBUTION OF INCOME PROFIT, RENT, QUANSI-RENT Comprise rewards for entrepreneurship, management, and risk-taking. Include normal profits and returns on innovation. Surplus from land based on fertility and location advantages. Rent reflects fixed supply of land but is subject to diminishing returns. Temporary surplus from specialized fixed capital. Arises in the short run when capital supply is fixed but disappears in the long run. INCREASING & DECREASING COST INDUSTRIES Alfred Marshall's concept of the "representative firm", a theoretical construct central to his economic analysis, especially in understanding production and costs in the nineteenth- century economy. 3 KEY FUNCTIONS It represented the average producer, neither the most efficient nor the least efficient, providing a basis for analyzing the "normal cost" of producing a commodity. Example: In the textile industry, a "representative firm" might be a medium-sized workshop producing fabric. If it costs this firm $10 to produce one yard of fabric, this $10 becomes the "normal cost" benchmark, ignoring the lower costs of a highly efficient factory or the higher costs of an inefficient, outdated workshop. 3 KEY FUNCTIONS The concept illustrated how an industry could remain in long-term equilibrium, despite individual firms growing or declining, as their changes offset each other. Example: In the restaurant industry, some businesses grow and expand into chains, while others shut down due to low demand. Even if the representative firm itself did not improve its efficiency, the costs of production could still decrease across the industry due to external factors, such as economies of scale or technological advancements, as the industry expanded. Example: In the smartphone manufacturing industry, the representative firm may not directly improve its internal efficiency. THE LIFE CYCLE OF BUSINESS ENTERPRISE Just as young trees compete for light and air, businesses face fierce competition. Over time, even the tallest and strongest trees lose vitality and are replaced by younger ones. The rise of large joint-stock companies changes this dynamic. The broader takeaway is that industries and economies are in constant flux, with businesses of different sizes rising and falling.  WHY DO FIRMS EXIST? The evolution of microeconomic analysis from Alfred Marshall's concept of the "representative firm" to Ronald Coase's groundbreaking insights into why firms exist at all. Marshall and early economists analyzed how firms function under different market structures (competition, monopoly, etc.). Ronald Coase addressed these questions in his 1937 article, The Nature of the Firm. He introduced the idea that firms exist to reduce transaction costs. However, as firms grow, internal costs—like bureaucracy, management inefficiencies, and erosion of entrepreneurial incentives—also increase. Coase argued that firms survive only if they can coordinate production more efficiently than the market.  INTERNAL ECONOMY EXTERNAL ECONOMY Efficiencies or cost savings that result from the growth Efficiencies or cost savings that arise from the and development of the entire industry, not just one growth of an individual firm. firm. Larger firms can afford to divide labor and tasks, As the industry grows, suppliers set up nearby, reducing improving productivity. transportation and material costs. They can use better machinery and scale Specialized transportation and logistics services emerge production to reduce costs per unit. to meet industry needs. Larger firms can secure credit on better terms Firms benefit from shared services or industry-wide and attract skilled managers. improvements in technology and knowledge. These advantages are available to all firms within the Bulk purchases and wider markets reduce costs. industry. These advantages are exclusive to the individual firm experiencing growth.  INCREASING & DECREASING RETURNS TO SCALE INCREASING RETURNS TO SCALE: When an industry's output increases, the cost per unit of production falls. This happens because labor and capital expansion improve organization and efficiency, particularly in manufacturing where raw material costs are relatively minor. DECREASING RETURNS TO SCALE: In industries heavily dependent on natural resources, like agriculture, expanding production increases costs per unit because of resource scarcity or limitations. WELFARE EFFCTS OF TAXES & SUBSIDIES JOIN THE FOR A CHANCE TO WIN AN AWESOME PRIZE! Join at www.kahoot.it Game Pin: